Does a variable annuity make sense for me?

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Does a variable annuity make sense for me?

Postby boggler » Mon Jul 15, 2013 3:46 am

I have a significant amount of taxable money to invest in the three fund portfolio (US stock, international stock, bonds). I have enough tax-advantaged space for the bond allocation. I intend to keep this money safe for many years, and I am currently in my twenties. Some questions:

- Does a variable annuity make sense here? I understand this would allow me to defer taxes on both gains and dividends, which is not possible if the money were invested traditionally in a mutual fund.

- I understand the fees are higher, in part due to a "mortality and expense risk" charge. What is this for? How is there any mortality and expense risk to the annuity provider if they are simply investing the funds on my behalf? (Is there some insurance feature that I've missed that this fee pays for?)
Assuming the total additonal fees are 0.3%, and annual dividend tax is 0.5%, it seems like you'd be better off with the VA over time.

- Would I be able to pass on the total value of the portfolio to heirs just as if the money were invested in a mutual fund? What differences are there between mutual funds and variable annuities in this respect?

- With the Vanguard annuity, can I get my money in and out at will without fees, like with their traditional mutual funds?

- You hear about "wealth managers" investing their clients assets in high expense mutual funds all the time. Why do you not hear about these same advisors investing assets in variable annuities?

Thanks. Would love to hear some responses.
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Re: Does a variable annuity make sense for me?

Postby bertilak » Mon Jul 15, 2013 6:32 am

boggler wrote:- You hear about "wealth managers" investing their clients assets in high expense mutual funds all the time. Why do you not hear about these same advisors investing assets in variable annuities?

Back in my pre-Boglehead days my Smith Barney "wealth manager" had me in both -- expensive load funds AND an expensive variable annuity. And I am not even in the high asset club. More like the barely adequate asset club and those high fees were a drag on that adequacy. So, I obviously "heard about" it!
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Re: Does a variable annuity make sense for me?

Postby nisiprius » Mon Jul 15, 2013 6:54 am

As you note, you have to pay all of your taxes on the money you contribute in the year you earned it--that is, you contribute post-tax money. When you make withdrawals, you pay taxes on all of the earnings--as ordinary income. So while it's giving you one tax break, it's taking away another. All that a variable annuity does for you is give you nontaxable compounding. As to how important this is, you should actually try doing the math, assuming a realistic investment growth rate that you choose yourself. The value of nontaxable compounding isn't negligible, but it is a completely different order of magnitude from the value of the tax break on a 401(k) (no taxes on contribution + nontaxable compounding) or Roth (nontaxable compounding + no taxes on earnings when withdrawn).

What does a variable annuity do for you that a traditional, nondeductible IRA wouldn't do better? It seems to me that you should at least max out a TIRA before considering a variable annuity. No forty-page fine-print onionskin prospectus to sign off on having read; any investments you like, not just a limited list of "portfolios" or "contracts," and real ticker symbols you can track...
boggler wrote:With the Vanguard annuity, can I get my money in and out at will without fees, like with their traditional mutual funds?
Not before age 59-1/2, you can't.
You hear about "wealth managers" investing their clients assets in high expense mutual funds all the time. Why do you not hear about these same advisors investing assets in variable annuities?
I haven't particularly heard any such thing and don't know if it's true. But then, I don't even know what a "wealth manager" is. I think it's a completely undefined term, no license, no credentials, anyone can call themselves a wealth manager. If I'm wrong, someone tell me--what is a "wealth manager?"

But to answer your question, it probably depends on industry affiliation. Most givers of financial advice seem to have their primary credentials and business associations either with the investment industry or with the insurance industry. While they may claim to have both, there is typically a primary orientation toward one or the other that becomes very clear. Thus, the insurance guy may tell you that he can sell you mutual funds but when you start asking questions he will find reasons why variable annuities are best for you. Insurance guys really do push variable annuities. I was unable to get a flesh-and-blood body-in-local-office to give me a quotation for an SPIA. He said they would, but said he really thought a VA would suit me so much better that he really wanted me to at least agree to take a look at one, then he sent me half a pound of material, and when I looked at it and told him I wasn't interested but please send me the SPIA quote I asked for, he said "sure" and never did.
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Re: Does a variable annuity make sense for me?

Postby dickenjb » Mon Jul 15, 2013 6:59 am

No it likely won't make sense.

Taxes are deferred but then everything gets taxed as ordinary income (no favorable treatment for LTCG and QDI).

If you die and leave it to your heirs, it is not stepped up for CG basis.

Costs are high, even for Vanguard's VA.

Let's say you invest in TSM in taxable and it pays a 2% dividend. You pay 0.3% (15%) in tax each year. When you choose to sell and pay cap gains, it is at 15%.

Let's say you find a VA with 0.3% M&E and the same 5 bps ER on their TSM fund (good luck with that!). You pay 0.3% every year and when the money comes out those dividends and cap gains get taxed as ordinary income at, say, 25%.

I think the M&E guarantees that if you die your heirs get the full value of what you invested even if the market is down at the time.
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Re: Does a variable annuity make sense for me?

Postby MN Finance » Mon Jul 15, 2013 9:09 am

This has been discussed a couple times recently, in fact I'm pretty sure you posed this same question once already. Instead of getting another thread going, I'd read the existing ones.

Low cost VAs can make sense in some cases when the time horizon is long enough, tax efficient space already filled, and used for inefficient assets. The compounding can make up for the less favorable tax treatment and higher cost. But the breakeven time horizon is decade, not years. And with today's interest rates, if they persist, the breakeven is nearly infinite.

I don't know about "wealth managers" but the fact that most good fee-only advisors in business for decades have gone their entire career without using one should tell you something.
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Re: Does a variable annuity make sense for me?

Postby boggler » Mon Jul 15, 2013 11:15 am

What if I assume that by the time I retire, there will be no special capital gains treatment? Since I'm already maxing out all available tax advantaged space, does this tip the balance?
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Re: Does a variable annuity make sense for me?

Postby boggler » Mon Jul 15, 2013 11:19 am

MN Finance wrote:This has been discussed a couple times recently, in fact I'm pretty sure you posed this same question once already. Instead of getting another thread going, I'd read the existing ones.

Low cost VAs can make sense in some cases when the time horizon is long enough, tax efficient space already filled, and used for inefficient assets. The compounding can make up for the less favorable tax treatment and higher cost. But the breakeven time horizon is decade, not years. And with today's interest rates, if they persist, the breakeven is nearly infinite.

I don't know about "wealth managers" but the fact that most good fee-only advisors in business for decades have gone their entire career without using one should tell you something.


Yeah, this is why I'm trying to understand the catch.

What do interest rates have to do with it?
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Re: Does a variable annuity make sense for me?

Postby MN Finance » Mon Jul 15, 2013 3:21 pm

boggler wrote:
MN Finance wrote:This has been discussed a couple times recently, in fact I'm pretty sure you posed this same question once already. Instead of getting another thread going, I'd read the existing ones.

Low cost VAs can make sense in some cases when the time horizon is long enough, tax efficient space already filled, and used for inefficient assets. The compounding can make up for the less favorable tax treatment and higher cost. But the breakeven time horizon is decade, not years. And with today's interest rates, if they persist, the breakeven is nearly infinite.

I don't know about "wealth managers" but the fact that most good fee-only advisors in business for decades have gone their entire career without using one should tell you something.


Yeah, this is why I'm trying to understand the catch.

What do interest rates have to do with it?


Because you presumably put only you tax inefficient assets in it (bonds and REITs). Ignoring REITs which make up a smaller part of a portfolio and can fit in your 401k, that leaves bonds for the annuity. If bond yields are 3% and you pay an extra 20bps in expenses, you are compounding 2.8% tax deferred. Whereas if yield are 6%, then you are compounding 5.8% tax deferred - the latter scenario makes compounding worth the extra expenses much quicker than the former.
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Re: Does a variable annuity make sense for me?

Postby spotty_dog » Mon Jul 15, 2013 3:34 pm

boggler wrote:- You hear about "wealth managers" investing their clients assets in high expense mutual funds all the time. Why do you not hear about these same advisors investing assets in variable annuities?


Hm, I'd say I've definitely heard those stories. They usually come in the same breath with advisors who push whole life insurance. There's a reason White Coat Investor/EmergDoc's site has several articles on the subject.
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Re: Does a variable annuity make sense for me?

Postby Hub » Mon Jul 15, 2013 4:29 pm

MN Finance wrote:Low cost VAs can make sense in some cases when the time horizon is long enough, tax efficient space already filled, and used for inefficient assets. The compounding can make up for the less favorable tax treatment and higher cost. But the breakeven time horizon is decade, not years. And with today's interest rates, if they persist, the breakeven is nearly infinite.

Interesting. I've always dismissed them out of hand (rightfully so in my situation) as a poor product. I think, based on what you say, I can envision a scenario where one would hold their bonds and REITs here for 30-40 years and make it work.
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Re: Does a variable annuity make sense for me?

Postby boggler » Mon Jul 15, 2013 5:04 pm

Any idea why costs haven't come down on these? If the costs were as low as Vanguard mutual funds, I imagine a lot more of us would be using these to save. Taxes might still be a concern, but the tax treatment is the same as a traditional IRA/401k, and I don't want to simply assume that the long-term capital gains preferential tax rate will still be around in, say, 40 years.
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Re: Does a variable annuity make sense for me?

Postby Case59 » Mon Jul 15, 2013 5:27 pm

This recent article in the NYT provides yet another strike against VA's (if any were needed). When circumstances occur where the VA owner actually might come out ahead, the insurance companies try to change the contracts retroactively. You are not permitted to "win."

http://www.nytimes.com/2013/07/13/your- ... money&_r=0
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Re: Does a variable annuity make sense for me?

Postby dhodson » Mon Jul 15, 2013 5:29 pm

boggler wrote:Any idea why costs haven't come down on these? If the costs were as low as Vanguard mutual funds, I imagine a lot more of us would be using these to save. Taxes might still be a concern, but the tax treatment is the same as a traditional IRA/401k, and I don't want to simply assume that the long-term capital gains preferential tax rate will still be around in, say, 40 years.


the taxes aren't the same. With a 401k you put money in pretax at your marginal at taking it out later hopefully at a lower rate. With this you are putting post tax dollars into the product where you have paid your marginal rate and then will pay income tax on gains at a later date (income rate would hopefully also be lower than when placed within product). For the products through vanguard the costs have come down a lot. Since they are selling so many at higher costs, why would most providers want to decrease the costs? They seem to be fine without attracting the boglehead crowd.

While its true that taking tax inefficient items like REITs/bonds and holding them for 30-40 years makes it seem reasonable, there just are better ideas for most people. First off if you know you are going to hold for 40 years then why not use a tax efficient index fund for a higher return, tax loss harvesting, step up basis at death, and improved liquidity. Most people are able to take their tax inefficient % and put it within their tax advantaged accounts. There likely is a very small % of people who feel they need more tax inefficient then they can put within their tax advantaged accounts or value the insurance features.
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Re: Does a variable annuity make sense for me?

Postby nisiprius » Mon Jul 15, 2013 7:10 pm

boggler wrote:Any idea why costs haven't come down on these?
Because they are insanely complicated products, almost nobody who buys them understand what they are buying, and they are not standardized in the way they work so they are all different and it is very hard to compare one company's product with another. Oh, and there isn't just one fee, there are all kinds of fees, layers and layers.

I looked at ONE of these ONCE. There was the heavy, glossy, magazine-like brochure with affectionate, healthy-looking senior couples who didn't look a day over sixty, smiling at computer screens on which ziggy lines went up, up, up, and a cute cartoon puppydog explained how with this annuity, it would never go down, but whenever the stock market did well you could "give yourself a raise." Guaranteed this, guaranteed that, guaranteed the other, and a cute cartoon puppydog. THAT is what the people who buy this product read.

Then there was a "prospectus," a thick wad of onionskin paper with dense, smallish, greyish print. I actually tried to read it, but my eyes glazed over, so I just settled for turning the pages and counting the number of different kinds of fees, until I lost count at seven.

The prices don't come down because the people who are buying them aren't even trying to compare prices, they are trusting the agent who tells them this is a good product that will take care of them in their old age.
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Re: Does a variable annuity make sense for me?

Postby boggler » Mon Jul 15, 2013 7:42 pm

nisiprius wrote:
boggler wrote:Any idea why costs haven't come down on these?
Because they are insanely complicated products, almost nobody who buys them understand what they are buying, and they are not standardized in the way they work so they are all different and it is very hard to compare one company's product with another. Oh, and there isn't just one fee, there are all kinds of fees, layers and layers.

I looked at ONE of these ONCE. There was the heavy, glossy, magazine-like brochure with affectionate, healthy-looking senior couples who didn't look a day over sixty, smiling at computer screens on which ziggy lines went up, up, up, and a cute cartoon puppydog explained how with this annuity, it would never go down, but whenever the stock market did well you could "give yourself a raise." Guaranteed this, guaranteed that, guaranteed the other, and a cute cartoon puppydog. THAT is what the people who buy this product read.

Then there was a "prospectus," a thick wad of onionskin paper with dense, smallish, greyish print. I actually tried to read it, but my eyes glazed over, so I just settled for turning the pages and counting the number of different kinds of fees, until I lost count at seven.

The prices don't come down because the people who are buying them aren't even trying to compare prices, they are trusting the agent who tells them this is a good product that will take care of them in their old age.


Heh. For shame.
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Re: Does a variable annuity make sense for me?

Postby Brian2d » Mon Jul 15, 2013 7:57 pm

Just wanted to add a clarification. The VAs at Vanguard are quite different from those described in the NY Times article. Those concerns don't apply to a Vanguard VA. Similarly a Vanguard VA without additional guarantees will lack the complexities of the VAs described.

I would likely advise against a Vanguard VA because the ordinary income treatment will likely wipe out benefits from un-taxed compounding but not because of the concerns raised about complicated VAs which are different from what the OP is considering.
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Re: Does a variable annuity make sense for me?

Postby johnanglemen » Mon Jul 15, 2013 9:09 pm

Yes, a variable annuity is worth it in your case. And you'll likely want to use Jefferson National's flat-fee annuity rather than Vanguard's. The fee will most likely be smaller depending on how much you're investing.
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Re: Does a variable annuity make sense for me?

Postby inbox788 » Mon Jul 15, 2013 9:32 pm

boggler wrote:I have a significant amount of taxable money to invest
I have enough tax-advantaged space for the bond allocation
I intend to keep this money safe for many years, and I am currently in my twenties.

Is this money for you or your heirs? What do you mean by safe? Do you mean riskfree? Chances are you're better off in bonds.

http://www.forbes.com/sites/davidmarott ... lculators/

What are you trying to achieve? You have various goals, and a variable annuity accomplishes some other goals. If they match exactly, unlikely, then you might look into it. But it's a very inefficient, i.e. costly, way to reach your goals. What again are your aims?

http://www.sec.gov/investor/pubs/varannty.htm

Note all the warnings!!!
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Re: Does a variable annuity make sense for me?

Postby inbox788 » Mon Jul 15, 2013 9:45 pm

johnanglemen wrote:Yes, a variable annuity is worth it in your case. And you'll likely want to use Jefferson National's flat-fee annuity rather than Vanguard's. The fee will most likely be smaller depending on how much you're investing.

Interesting. Don't know if it's enough to consider, but at least they're not as bad as before. The 4% cap mentioned here is disappointing. They're complicated instruments and you've got to know what you're buying, what's guaranteed, and what unrealistically optimistic example that is very unlikely to happen. In some ways, no, a lot of ways, it's a lot like whole life insurance.

http://webreprints.djreprints.com/3162660067128.pdf
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Re: Does a variable annuity make sense for me?

Postby boggler » Mon Jul 15, 2013 11:17 pm

johnanglemen wrote:Yes, a variable annuity is worth it in your case. And you'll likely want to use Jefferson National's flat-fee annuity rather than Vanguard's. The fee will most likely be smaller depending on how much you're investing.


Wow - this is a fascinating product. It's so low-cost that I'm wondering why more people don't use it. Do you use it?

I just learned that a VA insulates you from creditors and financial aid by "qualifying" your assets as retirement assets, which seems desirable. In other words, if the assets are truly for retirement, better to make that official to get the associated benefits by putting them in an IRA, 401k, or VA.
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Re: Does a variable annuity make sense for me?

Postby johnanglemen » Tue Jul 16, 2013 1:41 am

boggler wrote:
johnanglemen wrote:Yes, a variable annuity is worth it in your case. And you'll likely want to use Jefferson National's flat-fee annuity rather than Vanguard's. The fee will most likely be smaller depending on how much you're investing.


Wow - this is a fascinating product. It's so low-cost that I'm wondering why more people don't use it. Do you use it?

I just learned that a VA insulates you from creditors and financial aid by "qualifying" your assets as retirement assets, which seems desirable. In other words, if the assets are truly for retirement, better to make that official to get the associated benefits by putting them in an IRA, 401k, or VA.


Yes, I use it. It works well and the customer support has been good. I don't pay for any of the add-ons; I just use it as an extension of tax-advantaged space, as you're discussing here.

As for why more people don't use it, I don't think many people realize that it exists. The company doesn't promote it much to individuals directly; it's usually sold via advisors. But you CAN get it as an individual.
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